Prosperity Bancshares, Inc. (NYSE:PB) Q3 2023 Earnings Call Transcript

Prosperity Bancshares, Inc. (NYSE:PB) Q3 2023 Earnings Call Transcript October 25, 2023

Prosperity Bancshares, Inc. beats earnings expectations. Reported EPS is $1.2, expectations were $1.19.

Operator: Hello and welcome to the Prosperity Bancshares Third Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, today’s event is being recorded. I would now like to turn the conference over to Charlotte Rasche. Please go ahead.

Charlotte Rasche: Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares third quarter 2023 earnings conference call. This call is being broadcast on our website and will be available for replay for the next few weeks. I’m Charlotte Rasche, Executive Vice President and General Counsel of Prosperity Bancshares, and here with me today is David Zalman, Senior Chairman and Chief Executive Officer; H. E. Tim Timanus, Jr., Chairman; Asylbek Osmonov, Chief Financial Officer; Eddie Safady, Vice Chairman; Kevin Hanigan, President and Chief Operating Officer; Randy Hester, Chief Lending Officer; Merle Karnes, Chief Credit Officer; Mays Davenport, Director of Corporate Strategy; and Bob Dowdell, Executive Vice President.

David Zalman will lead off with a review of the highlights for the recent quarter. He will be followed by Asylbek Osmonov, who will review some of our recent financial statistics, and Tim Timanus, who will discuss our lending activities, including asset quality. Finally, we will open the call for questions. Before we begin, let me make the usual disclaimers. Certain of the matters discussed in this presentation may constitute forward-looking statements for purposes of the federal securities laws, and as such, may involve known and unknown risks, uncertainties, and other factors, which may cause the actual results or performance of Prosperity Bancshares to be materially different from future results or performance expressed or implied by such forward-looking statements.

Additional information concerning factors that could cause actual results to be materially different than those in the forward-looking statements can be found in our filings with the Securities and Exchange Commission, including Forms 10-K and 10-Q and other reports and statements we have filed with the SEC. All forward-looking statements are expressly qualified in their entirety by these cautionary statements. Now let me turn the call over to David Zalman.

David Zalman: Thank you, Charlotte, and good morning to everyone. I would like to welcome and thank everyone listening to our third quarter 2023 conference call. I am pleased to announce that the Board of Directors approved raising the fourth quarter 2023 dividend to $0.56 per share from $0.55 per share that was paid in the prior four quarters. The increase reflects the continued confidence the Board has in our company and our markets. The compounded annual growth rate in dividends declared from 2003 to 2023 was 11.5%. We continue to share our success with our shareholders through the payment of dividends and opportunistic stock repurchases, while also continuing to grow our capital. Our tangible capital increased $243 million from September 30, 2022 to September 30, 2023.

This is the amount Prosperity retained after paying $203 million in dividends and repurchasing $72 million of our common stock during this period, reflecting Prosperity’s stable earnings. Prosperity reported net income of $112 million for the quarter ended September 30, 2023, compared with $135 million for the same period in 2022. Our net income per diluted common share was $1.20 for the quarter ended September 30, 2023, compared with $1.49 for the same period in 2022. Prosperity’s earnings were primarily impacted by a lower than normal net interest margin. Although our net interest margin is lower than we would like, the good news is that based on our models, we show our net interest margin improving in a 12-month and 24-month time period to our more normal levels as our assets repriced to market rates.

However, if rates increase more than we anticipate, this could change. The net interest margin on a tax-equivalent basis was 2.72% for the three months ended September 30, 2023, stable when compared with 2.73% for the three months ended June 30, 2023. Prosperity continues to exhibit solid operating metrics with annualized returns on tangible equity of 12.58% and on assets of 1.13% for the third quarter of 2023. Our loans were $21.4 billion on September 30, 2023, a decrease of $221 million or 1% from the $21.7 billion at June 30, 2023. Our loans increased $2.9 billion or 15.8% compared with $18.5 billion on September 30, 2022. Excluding the loans acquired in the First Capital acquisition and new production by the acquired lending operation since May 1, 2023 and the warehouse purchase program loans.

Loans on September 30, 2023 grew $111 million or 2.3% annualized compared with June 30, 2023 and grew $1.4 billion or 8.2% compared with September 30, 2022. Interest rates have continued to increase, and there are signs of the economy slowing and loan growth moderating as intended by the Federal Reserve’s actions. Deposits were $27.3 billion on September 30, 2023, a decrease of $68 million, or 2 basis points, compared with $27.4 billion on June 30, 2023. Deposits decreased $2 billion, or 6.8%, compared with $29.3 billion on September 30, 2022, primarily due to a decrease in business deposits and public fund deposits partially offset by an increase in merger acquired deposits. After a more challenging time in the first quarter of the year due to large bank failures outside of Prosperity’s markets, our deposits stabilized during the third quarter.

Total deposits, excluding Public Funds, increased $260 million during the quarter. Importantly, this was achieved without the purchase of any brokered deposits. Our noninterest-bearing deposits represented a strong 37.6% of total deposits. Our non-performing assets totaled $69 million, or 20 basis points of quarterly average interest earning assets on September 30, 2023, compared with $62 million, or 18 basis points of quarterly average interest earning assets on June 30, 2023, and $19.9 million or 6 basis points of quarterly average interest earning assets on September 30, 2022. The increase during 2023 was primarily due to the merger and an increase in other real estate. Our asset quality remained sound and the allowance for credit losses on loans and off balance sheet credit exposure was $388 million on September 30, 2023.

As mentioned in our last conference call, the accounting for acquired loans has changed. Under the new accounting rules, the full loan balance of each acquired loan is booked at closing and a reserve as needed is set aside. Our nonperforming assets include approximately $23.7 million from the First Capital acquisition. The bank appropriately reserved for these loans at closing based on day one accounting. However, we are now doing a deeper dive into the collateral values and liquidation alternatives for these loans. If appropriate, charge downs to the allowance for credit losses may occur in the next several quarters. Again, these loans are fully reserved for. Our acquisition of Lone Star Bank shares is pending the receipt of regulatory approvals.

We are committed to the transaction and continue to work together with Lone Star in anticipation of the closing. The parties have extended the termination date in the merger agreement to March 31, 2024, and are prepared to complete the transaction as soon as possible following receipt of regulatory approval. Our operational conversion date is set for second quarter 2024. We continue to have conversations with bankers considering opportunities. We believe that higher technology costs, salary increases, loan competition, funding costs, succession planning concerns, and increased regulatory burden all point to continued consolidation. The Texas and Oklahoma economies continue to benefit from companies relocating from states with higher taxes and more regulation.

This combined with people moving to the states requires additional housing and infrastructure, a driver for loans, and increased business opportunities. Although, there are signs of the economy slowing and loan growth moderating, I believe our bank is located in two of the best states we can be for future growth and continued Prosperity. Thanks again for your support of our company. Let me turn over our discussion to Asylbek Osmonov, our Chief Financial Officer to discuss some of the specific financial results we achieved. Asylbek?

Asylbek Osmonov: Thank you, Mr. Zalman. Good morning, everyone. Net interest income before provision for credit losses for the three months ended September 30, 2023 was $239.5 million compared to $236.5 million for the quarter ended June 30, 2023, an increase of $3.1 million or 1.3%, and compared to $260.7 million for the same period in 2022, a decrease of $21.2 million, or 8.1%. The net interest margin on a tax equivalent basis was 2.72% for the three months ended September 30, 2023 compared to 2.73% for the quarter ended June 30, 2023, and 3.11% for the same period in 2022. Excluding purchase accounting adjustments, the net interest margin for the three months ended September 30, 2023 was 2.68% compared to 2.7% for the quarter ended June 30, 2023 and 3.1% for the same period in 2022.

Period end borrowings decreased $550 million during the third quarter 2023, primarily funded by cash flows from the bond portfolio. Non-interest income was $38.7 million for the three months ended September 30, 2023 compared to $39.7 million for the quarter ended June 30, 2023 and $34.7 million for the same period in 2022. Non-interest expense for the three months ended September 30, 2023 was $135.7 million compared to $145.9 million for the quarter ended June 30, 2023 and $122.2 million for the same period in 2022. The linked quarter decrease was primarily due to the merger related expenses in the second quarter related to the First Capital Bank acquisition. For the fourth quarter 2023, we expect non-interest expense to be in the range of $134 million to $136 million.

The efficiency ratio was 48.7% for the three months ended September 30, 2023 compared to 53.2% for the quarter ended June 30, 2023 and 41.4% for the same period in 2022. The bond portfolio metrics at 9/30/2023 showed a weighted average life of 5.2 years and projected annual cash flows of approximately $2.1 billion. And with that, let me turn over the presentation to Tim Timanus for some details on loans and asset quality.

H. E. Tim Timanus, Jr.: Thank you, Asylbek. Our non-performing assets at quarter end September 30, 2023 totaled $69,481,000 or 32 basis points of loans and other real estate compared to $62,727,000 or 29 basis points at June 30, 2023. This represents a $6,754,000 increase. The September 30, 2023, non-performing asset total was comprised of $60,126,000 in loans, $35,000 in repossessed assets, and $9,320,000 in other real estate. Net charge offs for the three months ended September 30, 2023 were $3,408,000 compared to net charge offs of $16,065,000 for the quarter ended June 30, 2023. This is a 79% decline on a linked quarter basis. There was no addition to the allowance for credit losses during the quarter ended September 30, 2023 compared to an $18,540,000 addition to the allowance during the quarter ended June 30, 2023 that resulted from the acquisition of First Capital Bank of Texas.

No dollars were taken into income from the allowance during the quarter ended September 30, 2023. The average monthly new loan production for the quarter ended September 30, 2023 was $398,000,000 compared to $565,000,000 for the quarter ended June 30, 2023. Loans outstanding at September 30, 2023 were approximately $21.433 billion compared to $21.654 billion at June 30, 2023. This is a 1% decrease on a linked quarter basis. The September 30, 2023 loan total is made up of 42% fixed rate loans, 27% floating rate loans, and 31% variable rate loans. I will now turn it over to Charlotte Rasche.

Charlotte Rasche: Thank you, Tim. At this time, we are prepared to answer your questions. Our call operator MJ will help us with questions.

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today’s first question comes from Brady Gailey with KBW. Please go ahead.

Brady Gailey: Hey, thank you, good morning.

David Zalman: Good morning, Brady.

Brady Gailey: I know in the past we’ve talked about the dynamic of the asset repricing pushing the net interest margin higher. I think previously you talked about a 3% margin within a year and like a 3.30% to 3.40% margin within a couple of years. Is that still the right way to frame the amount of NIM upside you’re seeing going forward?

Asylbek Osmonov: Every time I answer that question, Brady, I get looks in the room from my General Counsel that I’m supposed to be cautious on this all the time, but the answer is yes. I mean, our numbers are still showing, again, we’re showing – we feel like we’ve kind of bottomed out where we’re at. We feel there will be a decent increase in six months, 12 months and 24 months based on some of the numbers you just mentioned. And our models – we just ran our models again as of 9/30/2023, and we’re still showing that right now.

Brady Gailey: Okay. And you could get there tomorrow if you restructured the bond book. That’s such a big opportunity. And you guys clearly have the excess capital to consider doing something like that. I know it’s gotten more costly just with the tick up in rates that we’ve seen, but it also would be more EPS accretive if you pull the trigger. So maybe just updated thoughts on how you’re thinking about a possible bond restructuring or just a partial bond restructuring.

Asylbek Osmonov: Well, we’ve looked at it. I mean, again, you either hold the bonds for three years and you get your money back or you sell them right now and take your loss and you get your money back through an accounting accretion. But to me, that’s just kind of Voodoo Accounting, really. It would take our earnings from where we’re at next year at $500 million to maybe $600 million and something million or $650 million. I mean, it would just propel the earnings. But again, those earnings would be propelled primarily from accretion numbers in. More so than that, under accounting, you have to put your bonds either in available for sale or HTM. And since this bank has began, again, just because we were such an acquisitive bank, we always had to watch our capital.

And so we never could take the chances, when we didn’t have that much capital to have a lot of big changes in our capital account. So we pretty much put probably 90% plus of all of our securities in HTM. So you really couldn’t do it from an accounting standpoint. And if you did do it, once you did it, it would change everything. You couldn’t go back to the HTM.

David Zalman: That’s correct. And I can just add to his question. You said partially no. If you have to take the whole portfolio, you have to do the 100%. So the decision would have to do, do you want to take the whole portfolio or not? And I think at that point, with the duration being short and we can get all the cash within three, four years, we determine just leave it and let it reprice and use the cash flows for paying off our borrowing.

Brady Gailey: Okay. And then finally for me, just a quick one on the provision. It looks like you booked about $3 million of net charge offs, you built reserve by about $6 million. So I would have thought the provision would have been like, $9 million or $10 million, but it’s zero. So there must be something going on there.

Asylbek Osmonov: Yes. On the provision, Brady, we did put additional about $10 million for FCB, as we mentioned in our comments earlier. We’ll kind of dive in a little bit, and we put an additional $10 million that’s related to FCB, but the charge off $3 million was some of them were related to overdraft and loans. So it’s only $3 million.

David Zalman: It’s crazy the amount of – a lot of times it goes through that category, but probably a majority of a lot of that times, it’s just overdrafts and stuff like that.

Asylbek Osmonov: Combination overdraft and loans. Yes. And $3 million being not material, we determined we don’t need to provision anything this quarter. And our model shows that we appropriately have allowance balance.

David Zalman: Well, you have $388 million in allowance for credit losses and $60 million in non-performing. So I’d say we’re covered pretty good, probably.

Brady Gailey: That’s pretty strong. All right, great. Thanks for the color, guys.

David Zalman: I will say that a lot of that money, I mean, some of that money was First Capital reserves. I mean, we put, again, I don’t know the exact numbers at $85 million or so in reserves for First Capital…

Asylbek Osmonov: Including this – everything’s about $95 million.

David Zalman: $95 million?

Asylbek Osmonov: Yes. Including one-time…

David Zalman: But no matter how you look at it, $388 million, even if we decided to charge off – not charge off, but relook at some of those things, I think you still have $388 million or $60 million, it’s still a very strong position.

Brady Gailey: Great. Thank you.

Operator: The next question comes from Dave Rochester with Compass Point. Please go ahead.

Dave Rochester: Hey, good morning. Nice quarter.

David Zalman: Good morning, Dave. Thank you.

Dave Rochester: Appreciated the update on the longer term NIM outlook, and it’s good to hear the NIM has bottomed here, and that makes sense. Just given the repricing opportunity you guys have in the asset side. What are you guys expecting at this point for NIM more near-term? Any way to put some parameters around that expansion that you’re expecting here in 4Q and in the next year?